South Korea’s Looming Crisis

In the 1990s, South Korea waited for a crisis to erupt before responding with necessary reforms. But now the country is confronting a new set of internal and external risks, which it should nip the bud, both by pursuing domestic economic reforms and by working with China and the US to defuse the North Korean nuclear threat.

SEOUL – Twenty years after the Asian financial crisis, South Korea seems to have learned its lesson, having taken great pains to strengthen its economic resilience. But now the country is confronting a new set of internal and external risks, which may foreshadow another major economic crisis – or worse. Given the ongoing nuclear crisis with North Korea, a new bout of economic tumult is the last thing the country needs.

In July 1997, a currency crisis that struck Thailand quickly spread to neighboring economies. South Korea was not hit right away, and many believed that it would be spared. By that November, however, the country faced a sudden withdrawal of foreign capital, which, together with financial institutions’ inability to borrow from abroad, quickly depleted the country’s international reserves.

The following month, South Korea turned to the International Monetary Fund for assistance, and launched painful structural reforms. Companies and financial institutions went bankrupt, and millions of jobs were lost. In 1998, the economy contracted by 5.5%.

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Lee Jong-Wha, Professor of Economics and Director of the Asiatic Research Institute at Korea University, served as Chief Economist and Head of the Office of Regional Economic Integration at the Asian Development Bank and was a senior adviser for international economic affairs to former President Lee Myung-bak of South Korea. His most recent book, co-authored with Harvard’s Robert J. Barro, is Education Matters: Global Schooling Gains from the 19th to the 21st Century.

Lee Jong-Wha says South Korea is facing double whammy. The government under Moon Jae-in is grappling with external threats from North Korea, China and the US; as well as domestic challenges like stagnant growth, demographic decline and structural problems in its economy. South Korea survived the Asian financial crisis two decades ago after a cash injection from the IMF and emerged stronger and more resilient. GDP growth "soared to 11.3%, and government-led reforms made progress toward addressing structural weaknesses." Thanks to these reforms, South Korea withstood the 2008 global financial crisis and fared much better than most countries. "In this respect, the Asian financial crisis amounted to a blessing in disguise for South Korea."The author says, South Korea has in recent years been facing the similar woes that dogged Japan - economic stagnation, low birth rates, aging population, "labor-market inefficiency, institutional weakness, and low productivity in the service sector." Weak institutions posed an obstacle to fighting "excessive government regulations, opaque corporate governance, and policy instability." While the manufacturing sector has contracted in recent years, the services sector - finance, real estate, business services, and community and government services - "amounts to just 45%" of the manufacturing sector. This has much the "chaebol" to thank for - the wealth (chae) of the clans (bol) that rules South Korea. Family-run manufacturing conglomerates like Samsung, Hyundai et al dominate the economy and suffocate the country's attempt to shift gears and foster a more innovative services-oriented economy driven by small businesses. What worries South Koreans more is geopolitics. Apart from the existential threat that the aggressive North poses, Trump has not been helpful. His war of words with Kim Jong-un raises the spectre of an armed conflict, should both sides contemplate launching "preemptive strikes." As if it wasn't enough, Trump hinted at pulling out of the KORUS - the US-Korea Free Trade Agreement - hammered out by the Obama administration, amid heightened tensions on the Korean Peninsula. It enrages him that Washington runs a goods trade deficit of almost $28 billion with its long-time, key ally Seoul. In August the South decided to proceed with the temporary deployment of additional Terminal High-Altitude Area Defense system (THAAD) to guard against North Korea's missiles, following Pyongyang's launch of an intercontinental-range ballistic missile (ICBM) on July 28. THAAD was installed earlier this year and drew fierce criticism from China, which said the system's powerful radar would be used to spy on its territory. In response, Beijing boycotted South Korean goods to China, which accounted for 25% of South Korea’s total exports. Hyundai sales slumped 29% in China - the world's biggest car market - during the first half of the year, and the falling numbers of Chinese tourists to South Korea dealt a multi-billion dollar blow to the local economy.Amid bellicose rhetoric South Korea's president, Moon Jae-in sought to ease tensions with the North by returning to the "sunshine policy" of his predecessors. He and many South Koreans fear that "the unpredictable Trump /could/ go so far as to sacrifice South Korea (and Japan) to save San Francisco." Few predict that Kim Jong-un would strike first. But should Trump launch a preemptive strike on the North, Kim would not hesitate to annihilate the South. Moon's urge for “balancing sanctions and dialogue” earned him criticism from Trump for appeasing the North. Now South Korea is "debating whether to develop its own nuclear weapons or bring US tactical nuclear bombs back to its territory, which would antagonise Beijing. The author says South Koreans should see the current threats as a "blessing in disguise" as they offer them an opportunity - like two decades ago - to forge "domestic structural reforms to improve productivity, enhance labor-market efficiency, upgrade institutions, and foster a business environment that supports modern service industries and innovative start-ups." President Moon's acumen will be put to the test, and it remains to be seen whether he can deepen "both economic and diplomatic ties with major countries, while working with the US and China, in particular, to end the North Korean nuclear standoff."

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